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Five Perverse Incentives of the New Health Insurance Regulations

One of the many pitfalls of Affordable Care Act, I explained in my previous blog post, is that it requires insurers to spend no more than 20 percent of their income from premiums on administrative costs and no less than 85 percent on medical care. Regulating the medical loss ratio (MLR), as it’s called, is problematic, I argued, in part because the issue of which expenses can be considered legitimate “administrative costs” is highly open to interpretation.

This kind of regulation creates numerous perverse incentives, but in this post I will focus on five that I think will be especially pernicious.

First, just about any payment an insurer makes to a doctor or hospital is going to count as medical care, no matter how large the administrative costs are for the provider. So both entities have an incentive to find ways of shifting administrative costs from the insurer to the providers. The most obvious way of doing that is for the insurer to contract with an HMO, give the HMO a fixed fee per enrollee, and let the HMO manage all the care, no questions asked.

Second, almost anything the insurer does that conforms to the Obama administration’s view of “improving quality”—managed care, coordinated care, integrated care, electronic medical records—will count as “medical care.” But efforts to detect and prevent fraud will not count. Doctor credentialing won’t count either. One way to think about this is to realize that everything insurers are doing today to hassle good doctors will be encouraged and much of what they do to get rid of bad doctors will be discouraged.

Third, the days of the insurance broker are probably numbered. Since broker commissions won’t count as “medical care” and since the MLR is averaging about 70 percent, rather than 80 percent, in the individual market, insurers will cut back on commissions, and brokers may leave the market completely. Why should you care? Because in today’s bureaucratic health insurance system, brokers (along with employers) act as advisers and protectors. They answer questions, correct mistakes, eliminate confusion, and offer other customer services. Once they’re gone, you will be left on your own to navigate the complexities of the system.

Fourth, the minimum MLR restricts what insurers can spend to compete with each other in a way that favors larger firms and discriminates against smaller ones. Health insurers across the country are already leaving the small-group and individual health insurance markets, forcing people to find other sources of coverage. In the process, we are left with markets that are more concentrated, less competitive and offering consumers less choice. Here are a few examples, courtesy of the Galen Institute.[1]

The American Enterprise Group announced in October 2011 that it would drop non-group coverage for 35,000 people in more than 20 states.

In Indiana, nearly 10 percent of the state’s health insurance carriers have withdrawn from the market because they are unable to comply with the federal medical loss ratio requirement.

Cigna has announced that it is no longer offering health insurance coverage to small businesses in 16 states and the District of Columbia.

In Colorado, Aetna will stop selling new health insurance to small groups in the state and is moving existing clients off its plans this year, affecting 1,200 companies and 5,200 employees and their dependents.

In New Mexico, four insurers—National Health Insurance, Aetna, John Alden, and Principle—are no longer offering insurance to individuals or to small businesses.

These announcements are indicative of an accelerating trend that the American Medical Association says leaves four out of five metropolitan areas in the United States without a competitive health insurance market.[2]

Finally, insurers will be constrained in their ability to realize profits on their insurance business, but there will be no constraint on their profits from invested reserves. This means that in the business of insurance, the insurer will be like a regulated utility. There will be no incentive to take risks on developing new products because the insurer will not be able to reap the rewards of successful innovation. On the other hand, the insurer can realize the full return from risky investments outside the business of insurance.

A Better Solution: Deregulation

At a minimum, getting control of healthcare costs requires a vibrant competitive health insurance marketplace. The most important innovations in health insurance are not coming from the largest companies. They are being produced by smaller, more innovative companies aggressively competing to find a market niche. Imposing regulatory requirements that leave only one or two insurers standing will be self-defeating in the long run.